Final answer:
The financial tool to determine life insurance needs is called the human life value. It accounts for potential future earnings and economic loss if the insured passes away. Cash-value life insurance offers a death benefit and a cash account, while the law of insurance ensures premiums, on average, cover the costs and payouts.
Step-by-step explanation:
The financial tool used to determine the amount of life insurance a prospect would need is known as the human life value approach. This method takes into account the individual's income-earning potential over their remaining working years. When estimating the human life value, we consider factors like the prospect's age, occupation, current and future expected earnings, as well as inflation rates. It is essentially an assessment of the economic loss that would occur if the individual were to suddenly pass away.
Cash-value or whole life insurance provides not only a death benefit, which is the amount paid to beneficiaries upon the policyholder's death, but also a cash value component that grows over time and can be borrowed against or withdrawn. The accumulated cash value serves as a financial account that the policyholder can utilize during their lifetime.
According to the fundamental law of insurance, the average person's contributions to insurance over time must cover the average claims paid out, the costs of running the insurance company, and allow for the company's profits. This notion is critical in understanding insurance premiums and policy pricing.
Actuarially fair insurance policies are designed so that the premium paid is equivalent to the expected payout, considering the probability of a claim and the amount of coverage offered. The challenge of calculating these premiums is often complicated by the issue of moral hazard, where the existence of insurance can influence behavior and thus the likelihood or cost of claims.